Europe banks told to test on 2 adverse scenarios

Europe's banks have been asked to estimate how much additional capital they would need under two adverse scenarios as part of stress tests aimed at reviving confidence among investors.

The stress test process will be a hot topic when some 40 top bankers, including the heads of Deutsche Bank and UniCredit, meet European Central Bank President Jean-Claude Trichet in Frankfurt later on Wednesday, people familiar with the situation said.

Europe is testing 91 banks on how they would cope with another economic downturn and losses on some government debt, in an effort to restore confidence after the Greek crisis hit markets and sparked fears the eurozone could unravel.

With few details available about the terms of the test and early divisions among the 27 members of the European Union over how much to divulge, markets had begun to worry that the assessments would not be tough or transparent enough.

According to a document sent to banks and seen by Reuters on Wednesday, banks must estimate how much more capital they might need to achieve a Tier 1 capital ratio of 6 percent under the scenarios.

They have been asked to estimate their Tier 1 capital ratio at the end of 2011 under a base scenario, an adverse scenario including two years of economic deterioration, and an adverse scenario with an additional sovereign shock.

Sources said the template letter was sent to all the banks participating in the test, which is being coordinated by the Committee of European Banking Supervisors (CEBS). The results of the test will be published on Friday.

Bankers and officials from countries including Germany, France, Greece, and Belgium have said their lenders will pass the tests, raising concerns they are too lenient.

Markets had also been left wondering whether the test would be based on Tier 1 capital or core Tier 1 capital, which excludes some types of capital.

National regulators can vary on what qualifies as standard capital, and there has been concern among some investors that the test may not be evenly applied across all 20 countries.

The document seen by Reuters asks banks to estimate their total Tier 1 capital and their Tier 1 capital ratio at the end of 2011 under each scenario.

Under the harshest scenario, banks are asked to include cumulative losses for this year and 2011 for additional losses on sovereign exposures in the trading book and impairment losses on the banking book.

We are concerned that stress assumptions will be too weak to provide real clarity, analysts at Macquarie said. Particularly if a handful of banks that face severe domestic headwinds and no access to wholesale funding markets are given the 'all clear'.

Major listed banks are expected to pass, but the test results are expected to show the biggest problems lie with smaller players such as Spanish cajas and German landesbanks, which are mainly unlisted.

German nationalized lender Hypo Real Estate will likely fail the stress test, but officials from several countries have said their banks should pass.